Once a deficit hawk, McCain now focuses more on cutting taxes, "the lower the better."

Nigel Perry for Fortune

The Evolution of John McCain

As a maverick Senator, he took pride in just saying no to everyone's wish list. But as a presidential contender, he's become a tax cutter and defender of home mortgages. The inside story of how the candidate is shaping his plan to fix the economy.

Senator, what do you see as the gravest long-term threat to the U.S. economy?” That was the first question we put to John McCain when he sat down for an interview with Fortune on a sunny afternoon in June. The moment felt charged. Hillary Clinton had finally conceded to Barack Obama, and now the contest for the highest office in the land was down to two sparkling finalists—”the most impressive choice America has had for a very long time,” The Economist observed from overseas. Both were long shots when all this began. Each prevailed despite deep differences with key blocs in their party bases. Both promised change.

Already they were going at each other hard, mostly over the economy, and there was no shortage of bad news to fight about: turmoil in the markets, oil pushing toward $140 a barrel, gas at more than $4 a gallon, GM shutting down truck plants all over North America, unemployment arching higher than expected. All that was context for the question we posed. But we were asking McCain to rise above the news and look ahead to the day seven months from now when, he hopes, he’ll be sitting in the Oval Office. We wanted to know what single economic threat he perceives above all others.

McCain at first says nothing. He sits in the corner of a sofa, one black, tasseled loafer propped against a coffee table. We’re in the presidential suite on the 41st floor of the New York Hilton. McCain has come here—between a major speech on the economy in Washington, D.C., this morning and a fundraiser tonight at the 21 Club—to talk to us and to let us take his picture. He is wearing a dark suit, as he almost always does, with a blue shirt and a wine-colored tie. He’s looking not at us but into the void. His eyes are narrowed. Nine seconds of silence, ten seconds, 11. Finally he says, “Well, I would think that the absolute gravest threat is the struggle that we’re in against radical Islamic extremism, which can affect, if they prevail, our very existence. Another successful attack on the United States of America could have devastating consequences.”

McCain talks with workers at a shipyard in Jacksonville, Fla. He told Fortune: "I think the fundamentals of the U.S. economy are very strong. We're still the most innovative, the greatest exporter, the greatest producer."

Charles Dharapak — AP

Not America’s dependence on foreign oil? Not climate change? Not the crushing cost of health care? Eventually McCain gets around to mentioning all three of those. But he starts by deftly turning the economy into a national security issue—and why not? On national security McCain wins. We saw how that might play out early in the campaign, when one good scare, one timely reminder of the chaos lurking in the world, probably saved McCain in New Hampshire, a state he had to win to save his candidacy—this according to McCain’s chief strategist, Charlie Black. The assassination of Benazir Bhutto in December was an “unfortunate event,” says Black. “But his knowledge and ability to talk about it reemphasized that this is the guy who’s ready to be Commander-in-Chief. And it helped us.” As would, Black concedes with startling candor after we raise the issue, another terrorist attack on U.S. soil. “Certainly it would be a big advantage to him,” says Black.

Absent that horror, however, the 2008 election will probably be a referendum on two issues that, according to every poll we’ve seen, trump national security in the minds of voters right now. Both are problematic for McCain: the war in Iraq, now viewed as not worth fighting by two-thirds of Americans (according to a recent ABC News/Washington Post poll) but which McCain unbendingly supports; and the economy—especially the economy. “During bad economic times, history tells you people do blame it on the party in power in the White House,” says Black, a longtime Washington lobbyist who has worked in every Republican presidential campaign since 1972. So far, Black adds, voters seem willing to give McCain a pass, or at least a partial one. He polls much better when the choice is McCain vs. Obama than when it’s a generic choice of Republicans vs. Democrats. The GOP can only hope the distinction holds. In any case, McCain’s task is clear: He has to convince us, first, that he’s not George Bush and therefore not the one responsible for the economic mess we’re in, and second, that he knows how to clean it up, even if he did admit early in the campaign, “The issue of economics is not something I’ve understood as well as I should.”

McCAIN HAS SHOWN ZERO INTEREST IN PROPPING UP DYING INDUSTRIES, EVEN IF TO DO SO WOULD ALLEVIATE ECONOMIC SUFFERING IN THE SHORT TERM.

We didn’t have to spend a lot of time with McCain on the campaign trail to discover what really gets his mojo working. Let’s just say it’s not his plan to reform the unemployment-insurance system. There he was at an airport rally in Stockton, Calif., shouting out to his loyal pals in the Rolling Thunder veterans group who had parked their Harleys behind the stage: “Go ahead and start your engines for a second! Go right ahead!” And earlier that week in Chicago, addressing the other NRA—the National Restaurant Association—departing from his prepared remarks to accuse Obama of making light of the threat posed by Iran’s leadership. “They are the chief sponsors of Shiah extremists in Iraq,” he decried, his voice rising, “and their President has called Israel”—and here he paused for one beat—”a stinking corpse!”

On such occasions McCain conveys passion, commitment to a cause, a sure sense of who he is and why he’s running for President, and above all a strong connection to his audience. When the topic is economics, the same fire isn’t there—at least not yet. When he took part in an economic roundtable in Union City, Calif., with celebrity supporters John Chambers of Cisco Systems, Meg Whitman, former chief of eBay, Governor Arnold Schwarzenegger, and a panel of entrepreneurs, McCain took the opportunity to tick off some of the highlights in his stump speech: his insistence that “the foundation of our economy is incredibly strong”; his belief that when it comes to government, “the lesser the better,” and to taxes, “the lower the better”; and above all, his commitment to free trade. “Erecting trade barriers,” he said in his introductory remarks, “would be the most harmful thing we could do to America’s economic future.”

Some of that went over pretty well with the Silicon Valley techies in the crowd. But the economic landscape is nothing if not fractured. Tax cuts, investment credits, stimulus packages, trade deals, help with the mortgage, government contracts—everybody’s looking for whatever it is they’re looking for, and if they don’t get it they’re not happy. Michelle Moskowitz, who lobbies for the University of California at Berkeley, came to Union City hoping McCain would commit to more funding for basic research; she left disappointed. The overall tepid response McCain received from the people we spoke to afterward seemed to point up the peculiar challenge he faces when laying out his economic plan. How does a tough, uncompromising former prisoner of war—a self-described maverick who built his political reputation on straight talk—handle competing demands for limited resources during hard times, meanwhile keeping the ideologues in his own party at bay? Not always gracefully, it turns out.

For the lowdown on McCain’s economic plan, we turn to Doug Holtz-Eakin, the bearded, balding former director of the nonpartisan Congressional Budget Office, now McCain’s chief economic advisor. We meet at campaign headquarters in Arlington, Va., in a conference room on the M floor—M for McCain. (M is one above 12. The whole floor was renamed and relabeled by the campaign, right down to the buttons on the elevators. McCain is superstitious, his spokeswoman explained; it’s a fighter-pilot thing. But isn’t M the 13th letter in the … ? Never mind.) Holtz-Eakin is relating an anecdote from McCain’s first presidential campaign in 2000. The Senator was visiting a shuttered mill in South Carolina, talking to a worker who had lost his job. “And the guy said to him, ‘I worked in this mill for 30 years. What is my son going to do?’ And McCain looked at him and he gave the economist’s best answer. He said, ‘You know, I would have hoped that we both had higher aspirations for your son.'”

That’s classic McCain straight talk, a pure dose of it. Truthful, direct, maybe a tad harsh in that sometimes starchy Republican spirit of self-reliance, but with definite undercurrents of compassion and respect. I will not dissemble, is what he’s saying between the lines, because I believe you can handle the truth. How many of us ever hear stuff like that from our friends, much less from a politician who wants our vote? No wonder so many reporters fell in love with him, and not just because he was famously accessible to them. “But he had nerve,” Michael Lewis wrote about McCain in the New York Times in 1999, under the headline I LIKED A POL. “And his nerve was far more interesting than bravery in combat. It was the nerve of a man engaged in an experiment of behaving like a human being when everyone around him was playing this strange, artificial game.”

“WHAT THE CORPORATE WORLD HAS GOT TO UNDERSTAND IS THERE’S ANGER OUT THERE. AND [CORPORATIONS] HAVE TO RESTORE THEIR REPUTATIONS.”

At times McCain still shows flashes of his old uncompromising self. All last winter he campaigned in Iowa against ethanol subsidies, claiming they “distort” the market. He was right about that. In January he told autoworkers in Michigan: “Some of the jobs that have left the state of Michigan are not coming back. They are not. And I am sorry to tell you that.” He was right about that too, although saying so may well have cost him the Michigan primary. Last month in Stockton, days after he not only voted against the $307 billion farm bill (Obama was for it) but also vowed to veto any similar “pork-barrel-laden bill” that might cross his desk when he’s President, we heard a local reporter ask him, “How is that going to help you in the Central Valley?” It will not, obviously, which isn’t trivial. McCain’s staff thinks he might actually have a shot this year at winning California, something no Republican presidential candidate since George H. W. Bush in 1988 has been able to do. But McCain has been battling earmarks and pork-barrel politics his whole legislative career. He stood his ground. “There may be some people who don’t agree with my position,” he replied, “but I think you’ll agree that I’m doing what I think is best for this country.” Hard not to respect that.

But back to Holtz-Eakin’s story about the displaced mill worker in South Carolina. Turns out there’s a coda, and it tells us something about how McCain is approaching the 2008 campaign differently than he did in 2000. “This time,” Holtz-Eakin says, “when this campaign started, he looked at me and he said, ‘I know that you guys all thought that was a great answer. I’m happy to do the straight talk, but I need something more. These guys have gone to work’—he’s thinking about the autoworkers—’they’ve paid their taxes, they’ve sent their kids to school. Now what are they going to do?'”

To begin, they’ll still have to find another job—McCain hasn’t softened his position on that. He has shown zero interest in propping up dying industries, even if to do so would alleviate economic suffering in the short term. And we know that unlike Obama, who has wavered, McCain is dead set against protectionist trade policies. (“I stand for free trade,” he said at a Boston press conference, “and with all the difficulties and economic troubles we’re in today, there’s a real bright spot, and that’s our exports. Protectionism does not work and it will not work, and I look forward to that debate between myself and Senator Obama.”) But in his new more sensitive mode, at least he’s talking about a plan to ease the transition. He says he wants to give workers more control over how they choose to spend their benefit money, plus added incentives to get the training they need to land a better job, preferably in an industry that has a future. And he’s offering “special, targeted assistance” to workers over 55.

The candidate on the road with advisors Phil Gramm in Texas (left) and Carly Fiorina, en route to Pittsburgh. His role model is the late economist Milton Friedman, "the lodestone of thinking of the people that I admire and respect the most."

Gabriel Chmielewski — AP/BCS Eagle; Mary Altaffer — AP

Will that appeal to disaffected Clinton supporters? Conceivably. So might the populist themes we heard him sound repeatedly on the campaign trail. McCain wants greater “transparency and accountability” in government and markets. Moreover, he does not dispute that “the gap between executives and the workers has grown,” and he states flatly, “That trend should not continue.” One could argue that raising taxes on the wealthy would slow that trend; McCain is definitely not willing to go there. However, he does support so-called say-for-pay legislation, meaning he would give shareholders “advisory,” if not binding, input on CEO pay. “I think what the corporate world has got to understand is there’s anger out there with the American people,” he told Fortune. “And [corporations] have to act to restore their reputation, just as we in public office have to act to restore ours. Our approval ratings are basically at the same incredibly low level.”

The point where the line between populism and pandering begins to blur is McCain’s proposal for a summer gas-tax holiday. Eight years ago McCain would have ridiculed the idea and earned straight-talk points for doing so. Now Obama gets to be that guy, and he’s got lots of company. “Absolutely stupid,” says Norm Ornstein of the American Enterprise Institute, a pro-free-market think tank. “Embarrassingly so.” Even FedEx CEO Fred Smith, a prominent member of McCain’s kitchen cabinet of economic advisors—and someone who, in his words, burns “hundreds and hundreds and hundreds and hundreds of millions of gallons of fuel per year”—is skeptical. “Well,” Smith says, “I’m an ardent supporter of Senator McCain, but I don’t agree with him on everything…. Will it have any major effect on the energy crisis? The answer to that is no.”

McCain’s advisors insist that’s not the intent: “It’s a summer thing,” says Holtz-Eakin. “It’s an effort to help some people when they’re really getting hammered. And there aren’t a lot of levers to stop the short-term duress.” (Long term, McCain has said he would lift the quarter-century ban on offshore drilling in hopes of increasing domestic reserves.) But economists say the gas-tax holiday creates exactly the wrong incentive at a time when growing demand is driving fuel prices ever upward. Not that it matters what anyone thinks. The gas-tax holiday never stood a chance of being introduced in Congress, much less becoming law. So why even bring it up? Former Hewlett-Packard CEO Carly Fiorina, another McCain advisor, offers this frank explanation: “In the last three months the price of a gallon of gas has risen to the top of the American citizen’s agenda as the No. 1 issue, according to polling data. That’s the justification. It matters to people.”

IF HE’S FOR TAX CUTS NOW, McCAIN SAYS, THAT’S BECAUSE HE’LL LINK THEM TO SPENDING CUTS, WHICH PRESIDENT BUSH WAS NEVER WILLING TO DO.

Perhaps no issue has tested McCain over the years more than taxes. Four years ago, before he launched his second campaign for President, McCain was the keynote Republican speaker at a bipartisan conference on the budget titled “Restoring Fiscal Sanity—While We Still Can.” The event was sponsored by a half-dozen think tanks representing all points on the political spectrum. “I’m a proud Republican,” McCain said then, by way of introduction. “I’m a Barry Goldwater Republican. I revere Ronald Reagan and his party of limited government. Sadly, that party is no longer.” He went on to sharply criticize colleagues on both sides of the aisle for runaway “pork-barrel spending” and “expanding entitlements,” but he didn’t quit there. He also talked about taxes. “And why do we have to have tax cuts for the wealthiest Americans when the gap between the wealthiest Americans and the poorest Americans is growing?” he wondered. Later he added, “We’re at war. Tell me one time in the history of this country when this nation was at war when we’ve enacted tax cuts, especially for the wealthiest.”

Source: Urban-Brookings Tax Policy Center

McCain tried valiantly to hold the line. Twice he voted against Bush’s tax cuts, in 2001 and 2003, angering many in his own party. But that was then. Now, first step, McCain wants to make the Bush tax cuts permanent; then he wants to keep going. He would repeal the alternative minimum tax, slash the corporate tax, double the child-care tax credit, and, at least temporarily, allow businesses to write off the full cost of capital investments in one year. It’ll be expensive—the independent Tax Policy Center estimates, optimistically, that McCain’s plan would add $4.5 trillion to the national debt over the next ten years, compared with $3.3 trillion for Obama’s plan—but McCain insists that he can balance the budget in four years with promised savings from running a tighter ship and increased tax revenues as the economy expands.

Anti-tax crusader Grover Norquist of Americans for Tax Reform (ATR), who has sharply criticized McCain in the past, says now, “I’m happy.” Norquist still can’t get McCain to sign ATR’s no-new-taxes pledge, but he has the next best thing: video of the candidate promising as much on national television, three times. “With the campaign’s approval,” says Norquist, “we took those three YouTube videos and sent them to everybody and their brother on the planet.” Now when Norquist convenes his weekly Wednesday strategy meeting at ATR headquarters in Washington, there’s always a McCain campaign representative at the table. Apparently all is forgiven. “He was just voting against Bush in general” is how Norquist explains McCain’s reversal. “I think it was pique.”

McCain would never admit to that, of course. If he’s in favor of tax cuts now, the explanation goes, that’s because he’ll insist on linking them to spending cuts, which President Bush was never willing to do. And besides, allowing the Bush tax cuts to expire in 2010 would be tantamount to a tax increase. “Why hammer the economy at a time when it’s weak?” says Holtz-Eakin. Fair enough, although clearly it remains a sensitive issue for McCain, as does the question of how much his larger views have shifted and why, as he takes his last shot at winning the presidency.

Left: Nigel Parry; Right: Ben Baker — Redux

“My principles and my practice and my voting record are very clear,” McCain told Fortune near the end of our interview, and as he said so, he sat forward in his seat and looked us in the eye. “Not only from 2000 but 1998 and 1992 and 1986. And you know, it’s kind of a favorite tactical ploy now that opponents use, of saying the person has changed. Look, none of my principles or values have changed. Have I changed position on some specific issues because of changed circumstances? I would hope so! I would hope so!” That sound like straight talk to you? He sure hopes so.